There is a lot of theoretical information available about "actuarially fair" annuities. But, not only do these not exist in the real world of SPIAs, DIAs and variable annuities, the fact that the insurance company is taking the other side of a longevity bet means that they have to invest quite conservatively vs. say a static allocation with 50%-80% stocks since they are . So for example annuity payout rates are very correlated with interest rates. And overall it's hard to untangle the various aspects of costs in real-world annuities (administration costs, profit to insurer, sales commissions, drag from overly conservative investments, lack of inflation protection) to understand how much one would actually be getting in benefits over portfolio decumulation (a higher payout from mortality credits plus a lifelong guarantee of payout).

I'm interested in any and all information that shines light on the variables in this key decision that it seems most of us are faced with: whether to (fully or partially) annuitize.

There was a recent thread touching on this (viewtopic.php?t=238507) but I don't frame this as a yes/no question (whether to annuitize) but rather as a hypothetical - what parameters would an annuity have to have to make it compelling for me to annuitize rather than decumulate? Assume a lack of bequest motive, at least for the portion of portfolio prospectively being annuitized. And also assume a reasonable willingness to bear risk (maybe looking for 99% assurance that you will be dead before broke in case of decumulation, but that might translate into 95% or 90% "Firecalc success rate" given longevity expectations).

Something to keep in mind when comparing an "annuity vs decumulation", is an annuity is an insurance product, not an investment. There is value in the sleep-at-night factor offered by having your income literally insured for however long you (and potentially a beneficiary) may live, and less susceptible to issues managing a portfolio in cognitive decline. It will just about always 'lose' when looking it as strictly an investment, and not as a product that offers benefits besides it's expected return.

"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

As far as I can tell, the TIAA-CREF variable annuity payouts are very close to actuarially fair.

Most people that annuitize with them have made their investment choices over decades of accumulation, and are satisfied with their choices (or they would leave). You get a fixed percentage of shares from your account each month for life, depending on your age at annuitization. The price of those shares will change each month, up or down, but you will keep getting your payment for life unless the fund NAV goes to zero. If you die next month, your heirs may curse you. If you live a long time you may get back several times your investment. The better the market does, the better you do, with no caps or floor, and they don't exclude dividends like some S&P linked "Annuities" do.

This is not the common SPIA in that a specific amount is not guaranteed for life, but it is what I consider a very convenient and efficient decumulation strategy, for some but not all of your retirement assets.

We are pleased with a TIAA-CREF variable and fixed annuity received through employment. Payments have gone up yearly, but I don't completely understand how it is calculated.

We estimate that at least one of us will be long lived. A SPIA will payout around 6% yearly for life which will allow for a lower withdrawal rate from other funds. I think we will live longer than the actuaries expect given current health and family history. If not I won't worry about it. I would only annuitize a small amount of our investment portfolio so heirs should not be concerned. We are thinking of laddering SPIAs. We don't need any SPIAs, and of course the benefit will be eaten away in part by inflation.

I don't think either of these annuities are as good as delaying SS until 70 given the low interest rates of safe investments the last few years and other factors.

The more that comes into my checking account from various payers, the more it feels like still having a paycheck. Anything in my checking account I am more likely to spend and that is a good thing at this stage.

I don't think the first consideration should be how good a deal an annuity is; it's a tool for converting what you have (definite lump sum) into what you need (monthly payments for an indefinite number of years) and there's some loss in the conversion, but so what? You don't go on wearing shoes that fit you poorly just because you don't like the deal on getting new ones. (Insert jab at L. L. Bean here.) Nevertheless, it's relevant to know how badly the insurance company might be ripping you off. As nearly as I can tell, not really badly.

I've read a couple of stories that suggest that what could be called the "load" on a commercial annuity--the portion of premiums retained by the insurance company as profit, rather than being distributed to annuitants as payment--is in the 2% to 10% ballpark. Try web searches on "annuity moneysworth," as it is sometimes called a "moneysworth" calculation.

That pretty much tells me what I thought I needed to know. There's also a fairly narrow spread between the premiums charged by different insurance companies for the same annuity, suggesting though not proving that they are competitive and charging fairly close to their costs.

Most convincingly, I ran some numbers myself on a spreadsheet, playing amateur actuary with a mortality table, and that was enough to convince me that commercial annuities are, again, in the ballpark of what's reasonable and sane. They're not grotesque rip-offs.

The basic calculation isn't terribly hard. The last time I did it was years ago, so just for laughs I try it again, fresh, now.

Let's say you have a population of people, all age 65, who are about to buy an annuity that is going to pay them $10,000 a year for life. You use a mortality table to calculate how much you are going to need to pay out every year. Because insurance companies insure a self-selected population of people who have enough money to buy annuities and who have self-screened for known life-limiting conditions, the number we get is going to be too high; even if the insurance companies are completely fair, they cannot afford to pay out as much. But we're just looking for a ballpark. Let's use the Social Security table for females.

To make things very simple, let's actually use the numbers for number of lives right out of the table. Let's assume we start with exactly 87,914 females and that they have bought policies that will pay them $10,000/year.

First year, we will need to pay them 87,914 x $10,000 = $879,140,000
Next year, there are only 87,049 annuitants to pay, so we only need $870,490,000, and so on.

Now, assume we are going to make the payments by buying, today, on the market, some kind of bond that will make all the necessary payments in future. Again, to keep things simple, let's assume they are zero coupon bonds and that they have an average percentage yield of, oh... 2.5%, because a lot of the payments are going to be more than five years in the future and I don't want to bother trying to deal with a yield curve.

So, to make next year's payment of $870,490,000, we don't need to have $870,490,000 today, we discount that by 2.5%--we only need $849,258,536.59 today. (You divide by 1.025, not multiply by 0.975).

So we add them all up, and what we get is that in order to pay 87,914 people $10,000 a year for life, we need to buy $14,023,876,565.10 worth of bonds today, or $14,023,876,565.10 / 87,914 = $159,518.13. In other words, under the assumptions we've made, and zero profit for the insurer, they would need to set the premium at $159,518.13 for a payment of $10,000/year for life.

So we are seeing that according to this site, the average commercial insurer, for a premium of $159,518, will pay $823 x 12 = $9,876. That's definitely within striking distance of $10,000.

Everyone is now free to have fun pointing out problems in my assumptions and trying to do more precise calculations, but it's as far as I want to go. The premiums charged, and the payouts made by commercial, profit-making insurance companies are not crazy nuts numbers. They are not far, far less than what is "actuarially fair." They're about what it costs.

To show that there could be a less fair deal, I will point out the rates paid by charitable gift annuities. These are designed, with the full understanding of the donor, to be charitable contributions, not competitive or fair annuity rates. Many charities (if you've been to college and you're getting on in years, your alma mater probably has one and is probably already sending you junk mail about it) pay out according to this table, so for $159,518 they will pay out $159,518 x 4.7% = $7,497/year.

I still don't know a good anonymous way to post a spreadsheet, but if you want to reproduce my numbers, here are the two columns of numbers, the left column being the number of dollars that must be paid out each year, and the right column being the cost, today, of buying a bond or something that will make that payment in that year. The left column is the "female number of lives" table from the 2014 period life table, starting at age 65.

...I've read a couple of stories that suggest that what could be called the "load" on a commercial annuity--the portion of premiums retained by the insurance company as profit, rather than being distributed to annuitants as payment--is in the 2% to 10% ballpark....I ran some numbers myself on a spreadsheet...let's assume they are zero coupon bonds and that they have an average percentage yield of, oh... 2.5%...

Thank you nisiprius, this is really helpful. Actually I'd love to get your spreadsheet if you would be willing to post it or PM me.

BUT... it is apples to apples comparison with decumulation (sequenced withdrawals) only if your portfolio in decumulation was going to be invested entirely in zero-coupon bonds. But of course most of us would be investing in a balanced portfolio with significantly higher nominal return expectations. OK, this has a risk of failure (hence the endless SWR threads) and the insurance company is making a promise and must invest (and per State laws reserve) accordingly but to me as an investor apples-to-apples is the annuity payout vs. say a Firecalc 98% safe number (and factoring in inflation, i.e. if comparing annuity to the infamous rule-of-thumb 4% starting portfolio withdrawal that's then adjusted for inflation it must be an inflation-indexed annuity). I.e. this is not about how much the insurance company is pocketing but how much extra spendable income I get from annuitizing.

Not the same, OP.
Primarily annuities and their variations (pensions) are Insurance products.
MF are investment products.
The experts at BH try to compare the two using the same metric for investing.

Everyone here knows by now, know that we have GLWB Annuities within IRAs.
They (GLWB) are essentially a Long Straddle option. Because I ladder them, they also become a Strangle option. They are NOT Investments but a way for me to assure a certain IRA income in the future. I give up a certain amount of potential investment but gain in the protection of a guaranteed future income.
There are inconsistentes where the annuity company misprices (terms of contract) their Annuities. This is the Investment part and I took advantage of that knowledge.

Look at Vanguard's GLWB. Look at the graphic. Can you discover what I saw in Nov 2008?
Ymmv

Not the same, OP.
Primarily annuities and their variations (pensions) are Insurance products.
MF are investment products.
The experts at BH try to compare the two using the same metric for investing.

Everyone here knows by now, know that we have GLWB Annuities within IRAs...

Yes, I want comparison of spendable income between investment product and insurance product, within the limits of what would reasonably be considered "safe" in the case of investment (or variable insurance product). The point is to untangle the value of the shared mortality credits from the value of the "guarantee" by the insurance company (the reason for the zero-coupon bond assumption by nisiprius in this reply above), and the profits/fees to the insurance company (which I accept are probably in that sub-10% level, rather than a crazy level, for competitively-priced SPIAs... that being said a 10% drag on returns is not trivial over a long retirement).

^ don't have SPIA. You can give up too much at the backend, died too early. Straight put option, at-the-money. You lose on up markets and dying early. You win, in prolonged down markets and live too long. Winning in SPIA are long odds if you look at SPIAs as investments, but for Income they could be OK if you ignore everything else.

It's odd that recent threads on buyouts of defined benefits (pension) to annuities vs cash out into IRAs have been tilted towards annuities.
YMMV

Last edited by itstoomuch on Mon Feb 12, 2018 1:55 pm, edited 1 time in total.

Don't mistake nominal monthly income payments from SPIAs for real inflation adjusted income over a long time span. You do not know up front what the cumulative rate of inflation will be over the next 20 or 30 years. Hence unless you get an inflation adjusted annuity you cannot determine the level of real monthly income (the only kind that counts) for spending purposes in the future. Nominal SPIAs may sound compelling to the risk averse after decades of low and decreasing inflation (which have recency reversed a bit), but do not confuse SPIAs with safety unless they are only a portion of your portfolio and there is inflation protection (TIPS, MM, equity, etc.,) elsewhere in the portfolio. Persistent and increasing inflation is a killer for fixed payment annuities, and although we haven't had it in recent past history, that does not guarantee that it doesn't happen in the future. If you decide on annuities, I suggest you do so only partially unless senility is taking hold of you. I also suggest you use only SPIAs (lower sales commissions) and defer purchase of a SPIA as long as practical in your circumstances. Deferring purchase shortens the anticipated time span of coverage, hence it lowers inflation risk and increases monthly income per dollar of annuity cost. Annuities do provide longevity insurance (good if you're very healthy for your age, bad if the opposite) and some measure of financial security, but those things don't come free. As long as you have your marbles and investing competence you can outperform SPIAs but deciding when you're losing it is a tricky question.

As far as I can tell, the TIAA-CREF variable annuity payouts are very close to actuarially fair. ...

What do you mean by "as far as you can tell"?

I mean that as far as I can understand the TIAA-CREF explanation, (which includes an assumed 4% yearly increase), and as well as I can do the math, the payout matches the underlying funds and life expectancies.

Try going to the TIAA-CREF site, and see if you can fully understand the methodology, and then come here and explain it to the rest of us.

I know that many here use this annuity strategy, and are satisfied with it.

Most convincingly, I ran some numbers myself on a spreadsheet, playing amateur actuary with a mortality table, and that was enough to convince me that commercial annuities are, again, in the ballpark of what's reasonable and sane. They're not grotesque rip-offs.

The basic calculation isn't terribly hard. The last time I did it was years ago, so just for laughs I try it again, fresh, now.

[snip]

Everyone is now free to have fun pointing out problems in my assumptions and trying to do more precise calculations, but it's as far as I want to go.

Instead, let me point out how to do less precise calculations with shakier assumptions...

A quick and dirty way to estimate the "fairness" of a SPIA quote is to use a mortgage calculator. Plenty of those are available online, no need for a spreadsheet.

Those generally are solving a nonlinear equation in four variables: the amount loaned, the monthly payment, the interest rate, and the number of payments. The good calculators will let you specify any 3 of the 4 variables and solve for the fourth.

Here of course we are the bank, loaning cash to an insurance company in exchange for a series of monthly payments. Copying the terms of your quote, we have a $159,518 preminum, age 65 female PA resident and a monthly payment of $823. So we've got two of the four variables.

For a third, you can argue that "fairness" can be roughly measured relative to life expectancy. I'll skip the mortality tables and make a wild guess of 20 years (240 payments). That implies an APR of 2.21%. For 21 years, 2.61%; for 22 years, 2.96%.

What surprises me most about this calculation is to see how sensitive the implied interest rate is to the assumed life expectancy. It suggests that *accurate* mortality tables are absolutely critical for this biz.

Also, I changed your annuitant from female to male and got a quote of $863/mo. The corresponding implied interest rates were 2.73%, 3.11%, and 3.45%. In order to get the implied interest rate to match the female 2.21% rate @ 20 years, I have to set the number of payments to 226 (18 years + 10 months). I would have guessed that the difference would be more than 14 months.

... As long as you have your marbles and investing competence you can outperform SPIAs...

Ah, but this is precisely what I am trying to find a means to compare. And clearly your statement is wrong for, say, a 90-year old male considering whether to annuitize - the value of mortality credits means that SPIA income will certainly dwarf portfolio withdrawals no matter the level of investing competence, unless he wishes to take an exceedingly high risk of outliving his money. So the question is, whether it's the case for a 65-year-old as well (assuming no bequest motive).

...
A quick and dirty way to estimate the "fairness" of a SPIA quote is to use a mortgage calculator. ... you can argue that "fairness" can be roughly measured relative to life expectancy. I'll skip the mortality tables and make a wild guess of 20 years (240 payments). That implies an APR of 2.21%. For 21 years, 2.61%; for 22 years, 2.96%.
...

Nice quick & dirty method but, if fairness is measured relative to life expectancy and you are only making a wild guess of 20 years, how can you decide if the SPIA quote was fair?

Anyway your and nisiprius calculations don't address my real question - measuring the likely total consumption of the two options (SPIA vs. decumulation). To use nisiprius $159,518 example: that implies at the classic 4% "SWR" a starting withdrawal of $6,376 - much less than $10,000 - but going up with inflation. Where is the break-even based on a given assumed inflation rate (say, 2%)? And how about if you start with 3.5% instead of 4% (for safety)? Or to flip it around, under a given assumed inflation rate what is the fixed withdrawal (not adjusting for inflation) that would be equivalent in Firecalc-safety of a given withdrawal (such as 4%) that is inflation-adjusting? That would allow comparing the income stream apples-to-apples (and since retiree spending typically does diminish during retirement there is an argument for consumption maximization to use lack of inflation protection as an implicit glide path for real spending).

I answered my own question. I went to immediateannuities.com and for a 65 year old male with a 60 year old spouse and a CPI cola rider the payout is 3.2% for a payment that extends to the longest surviving spouse.

I answered my own question. I went to immediateannuities.com and for a 65 year old male with a 60 year old spouse and a CPI cola rider the payout is 3.2% for a payment that extends to the longest surviving spouse.

And, without the spouse payout is 4.38%. So I guess that does kind of answer my original question: a 65-year-old male can make a 9.5% bonus over a 4% "SWR" (while avoiding the small chance of running out of money), at the cost of not leaving a bequest (since in most cases 4% SWR is conservative, average terminal portfolio is large). But, that's still a pretty small bump, all in all.

I answered my own question. I went to immediateannuities.com and for a 65 year old male with a 60 year old spouse and a CPI cola rider the payout is 3.2% for a payment that extends to the longest surviving spouse.

And, without the spouse payout is 4.38%. So I guess that does kind of answer my original question: a 65-year-old male can make a 9.5% bonus over a 4% "SWR" (while avoiding the small chance of running out of money), at the cost of not leaving a bequest (since in most cases 4% SWR is conservative, average terminal portfolio is large). But, that's still a pretty small bump, all in all.

Yes - agreed. But even that small 9.5% bonus might be much smaller when you consider the tax implications of the annuity over the alternatives.
I am sure it varies a lot by individual but in our case the taxes with a fixed annuity would greatly hurt our relative 'spendable' income.

I answered my own question. I went to immediateannuities.com and for a 65 year old male with a 60 year old spouse and a CPI cola rider the payout is 3.2% for a payment that extends to the longest surviving spouse.

And, without the spouse payout is 4.38%. So I guess that does kind of answer my original question: a 65-year-old male can make a 9.5% bonus over a 4% "SWR" (while avoiding the small chance of running out of money), at the cost of not leaving a bequest (since in most cases 4% SWR is conservative, average terminal portfolio is large). But, that's still a pretty small bump, all in all.

Yes - agreed. But even that small 9.5% bonus might be much smaller when you consider the tax implications of the annuity over the alternatives.
I am sure it varies a lot by individual but in our case the taxes with a fixed annuity would greatly hurt our relative 'spendable' income.

Can you explain more? Is this because it would be from a taxable account and so results in ordinary income (other than for return of principal portion) vs. sequenced withdrawals where gains are mostly capital gains and dividends?

OP wrote:I'm interested in any and all information that shines light on the variables in this key decision that it seems most of us are faced with: whether to (fully or partially) annuitize.

JMO.
Annuities are insurance products. Sometimes you get more than you put in. Sometimes not. You are sharing the risk with annuity company.

Decumulation is on Your funds. You take the risk.

There are times where there are mis-pricing of annuities; Because they are far future option products, the mis-pricing can occur fairly frequently. There is an institutional bureaucracy which is slow to react to gross changes because they have to tolerate short-term changes like the early February's "correction".

I answered my own question. I went to immediateannuities.com and for a 65 year old male with a 60 year old spouse and a CPI cola rider the payout is 3.2% for a payment that extends to the longest surviving spouse.

And, without the spouse payout is 4.38%. So I guess that does kind of answer my original question: a 65-year-old male can make a 9.5% bonus over a 4% "SWR" (while avoiding the small chance of running out of money), at the cost of not leaving a bequest (since in most cases 4% SWR is conservative, average terminal portfolio is large). But, that's still a pretty small bump, all in all.

Yes - agreed. But even that small 9.5% bonus might be much smaller when you consider the tax implications of the annuity over the alternatives.
I am sure it varies a lot by individual but in our case the taxes with a fixed annuity would greatly hurt our relative 'spendable' income.

Can you explain more? Is this because it would be from a taxable account and so results in ordinary income (other than for return of principal portion) vs. sequenced withdrawals where gains are mostly capital gains and dividends?

Yes - with annuities you have much less control on when you might take the money and it is ordinary income. If it stays with you in a taxable account you can work with capital gains, dividends and maybe things like rentals. Control of timing and control of investment vehicles are the difference with taxes.